JF1971: How to Find Good Investments When Prices are High and Markets are Ultra-Competitive with Steve O’Brien

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Steve O’Brien, co-founder and Chief Investment Officer of Arcan Capital, has been responsible for the acquisition of over 20 multifamily assets totaling over $300MM in the past five years. On this episode, Steve tells us four ways for how they stand out from the crowd and find deals in their competitive market. Listen to Steve’s Best Ever Advice to learn how you can get the edge and win deals in your market. 

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“If you can get your investor to accept a lower yield and a lower IRR that’s more in line with where your market is today, you’re going to be able to find yourself more competitive.” – Steve O’Brien, Arcan Capital

Steve O’Brien’s Real Estate Background:


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TRANSCRIPTION

Joe Fairless: Best Ever listeners, how are you doing? Welcome to the best real estate investing advice ever show. I’m Joe Fairless. This is the world’s longest-running daily real estate investing podcast where we only talk about the best advice ever, we don’t get into any of that fluffy stuff. With us today, Steve O’Brien. How are you doing, Steve?

Steve O’Brien: I’m doing well.

Joe Fairless: Well, I’m glad to hear that. Best Ever listeners, in case you don’t recognize Steve’s name, well you can go to Episode 940, titled “Why VALUE-ADD Multifamily Properties ROCK!” and Episode 1048, titled “Focusing on Lenders to Make MORE MONEY!!” It’s a Skillset Sunday with Steve O’Brien.

Today we’re going to be talking about how to find good investments when prices are high and markets are ultra-competitive. I think most of us have experienced this challenge. That’s why we’re doing a special segment on Situation Saturday. So Steve has been responsible for the acquisition of over 20 multifamily assets totaling close to $200 million in the last five years. He’s placed nearly $100 million in financing. Like I mentioned, he’s been on the show a couple times before. So first, Steve, how about you give the Best Ever listeners a refresher on your background, and let’s roll right into how to find good investments when prices are high and markets are competitive.

Steve O’Brien: Thanks for having me again. I am the Chief Investment Officer and co-founder of Arcan capital. We’re based in the Atlanta area and focused on value-add, multifamily investing in the south-eastern United States. It’s funny as you read that intro, it’s been a busy few years because I think numbers are actually closer over $300 million and $200 million in financing now, and $300 million in total acquisition. So it’s been a nice run, as I think it has been for lots of people this cycle.

Joe Fairless: Nice, congratulations on that. So with that being said, you just mentioned, “Hey, bump me up another hundred million in each of those two categories.” So you are finding deals, but it is an ultra-competitive market. So how are you all finding deals? And then we’ll apply that to how everyone can try to find deals in a competitive market.

Steve O’Brien: Absolutely. So I think one of the things we’re doing as we prepare for the end of the cycle here – we’ve had the longest economic expansion in US history, and things are going really well. I think, by any measure, you’ve got really good data, and lots of money raised to buy not just apartments, but lots of deals. So there are a lot of ways that we try to separate ourselves from the crowd,  and one of them takes a long time and that’s reputation, particularly in a market where brokers and sellers – everybody talks, so everybody knows, as big of a market as it is, sometimes it feels like it’s really small. One of the best ways that we’re able to find deals now is by doing what we say we’re going to do, doing really good, thorough underwriting on the front-end. So when we say, “Hey, I’m going to buy this deal for $15 million,” we don’t come back and get into a re-trade battle, because sometimes those re-trade battles can leave a really sour taste in a seller’s mouth and a brokers mouth. Whether we like it or not, in our experience, the only way you win deals in a market where everybody’s healthy and is ultra competitive is by somebody picking you over someone that’s probably pretty close, either in price or in terms or some other way.

So we’re very focused on reputation and doing what we say we’re going to do. A lot of times that means you don’t win the deal because someone else has offered a really big number… But we find that a lot of times people will come back to us and say, “Hey, Steve, we had somebody say they’d pay x million for this and they re-traded by 250k. Are you guys still there at your number?” So sometimes, we’re the second place or third place buyer, but because they know we’ll perform– once a seller’s had a bad experience, a lot of times they’ll say, “You know what, I just want somebody to give me a good number that will actually close.” So we find that’s definitely a way to win some deals.

Joe Fairless: Let’s pretend that you no longer have your company and you have to start a new company, for whatever reason. How do you get ultra-competitive then? Because what I heard is, “Have a good reputation.” Your company has a good reputation, doing what you say you’re going to do. With a beginner, that won’t help them as much, or at all really, because they don’t have a reputation. So how would you go about getting deals in an ultra-competitive market when you don’t have that to rely upon?

Steve O’Brien: I think there are a ton of different ways that you can skin this cat, but reputation is great. But to your point, you’re starting from scratch or you’re in a new market, even. If we were to go to Kentucky, where we’ve never purchased anything, people would say, “Who are these guys?” So I think what you’re doing there and what we focused on is making sure your underwriting is great, and having enough data that you can push in other ways people haven’t figured out; maybe that’s having a really good contractor that can get you really good pricing, or really accurate pricing on the way in. If something needs a new roof or something needs new siding, and you can get a really accurate quote… Sometimes people overestimate what it’s going to cost. So as a part of your diligence, when you’re going around before you’re offering, they’ll give you pretty good access to the property. They’re probably not gonna let you do a full diligence process, but if you bring a contractor with you and have them really price out some items, maybe you figure out that the deal only costs $250,000 to do what you want to do, and somebody else’s penciling at half a million. That’s a great way to get aggressive.

I also think communicating with your investors is huge, because part of the reason, I think, things are so competitive right now, is people and investors have a certain expectation of return. So one of the things we’re doing a lot of right now is communicating with our investors on how the market is changing, because the reality is the returns today, even on a very similar deal that you feel great about, in our opinion, they’re just not as high as they used to be. If you can correctly convey that to your investor and get them to accept a lower yield and a lower IRR that’s more in line with where market is today, you’re going to be able to find yourself more competitive. When all the stats are good and everybody’s got money raised, the reality is people are going to squeeze returns. That doesn’t mean the deals are bad, it just means they may not pencil — if they were penciling out to a 20 IRR before, maybe it’s only a 15 right now. But if your investors understand the market and understand that in today’s market a 15 is a great return or a 12 is a great return, whatever it is, that could create some opportunities for you too, and let you get a little bit more aggressive in finding a deal. Historically, I think I’ve seen recently, average return on multifamily investing is around a 14%. So we’ve had a pretty good run here.

Joe Fairless: 14% what? IRR, or…?

Steve O’Brien: IRR, Internal Rate of Return. I think that’s a Real Capital Analytics number. So historically, there aren’t a lot of people who, if you get them a 10% IRR historically, with some cash flow along the way, are going to be angry. But because things have been so good up to this point, people will look at deals that have those type of metrics and say, “I don’t know, I don’t want to do that. That’s not quite as lucrative.” But you may be missing some really good deals if you do that.

Joe Fairless: I love both those points. Thank you for sharing both. We’re going to talk more in detail about each of them. Let’s go with the second one, because that’s what you talked about last, communicating with investors to level set the returns. Specifically, how do you go about communicating that?

Steve O’Brien: Well, I think it depends. We’ve traditionally been a syndicator. So on a deal by deal basis, we found a property and we then go raise the money for the property in a number of ways, whether that’s a group of our own investors that we get together, or a mix of our own investors and a large investment shop that may put a path to 90% of the total equity. Regardless, you’re having to sell people on a deal after you sell yourself on it. So we use newsletters, we do quarterly reports for every deal that we have, we send monthly reports out for every deal that we have. So it creates an open line of communication between you and your investors where you can give them some market data, and hopefully they’re reading the information. As you write your report, you can allude to certain factors that are going on in the market. You can allude to investors that, “Hey, we’re not getting the rent increases that we thought we were going to get,” or “Hey, we’re getting twice what we thought.” So that when you come back to them, you’re not getting a call from an investor saying, “How’s that deal doing?” They’re going to understand, and they’re going to have a better picture of what’s going on.

So we found that as we do that, and you pick up the phone and call them, which is another important thing to do –  it’s very old fashioned, but sometimes the best thing to do is to just make a list every quarter and say, “I’m going to call my 50, 20, 100 investors and just say “Hello.” Almost all the time, at least in our situation, they’ll ask, “Hey, how are things going? How’s the market?” and it’s a chance to update them. So we do that heavily through communication on a regular basis through newsletters, phone calls and reporting.

Joe Fairless: If I heard you correctly, you said you do newsletters, you do quarterly reports and monthly reports. Did I hear you correctly, first off?

Steve O’Brien: Yes, that’s right.

Joe Fairless: Okay. So what’s the difference between each of those three?

Steve O’Brien: So the newsletter is, I think, just more informational – “Here’s what we’re seeing.” In the newsletter we’re actually about to launch we wrote a couple articles on actually this topic, “How do you make money in a market that’s very competitive?” like this one, and bigger picture macro discussion about the economy and where we think the economy is headed. So that’s our newsletter; maybe we include some information about ourselves, a good story, but we try to keep people updated on the market and something that’s going to keep people interested. The quarterly reports and the monthly reports are–

Joe Fairless: Is that emailed out?

Steve O’Brien: It is. We do an email through a service that sends it out to people on our list.

Joe Fairless: What service do you use?

Steve O’Brien: We actually use Constant Contact, which I think is phenomenal. It’s actually one of the bigger ones.

Joe Fairless: How often do you do the newsletter?

Steve O’Brien: Really, we try to do it quarterly. But we really are focused on doing it when we have something to say. So sometimes it’s six times a year, maybe it’s four times a year. But we’re really going to be focused on getting that out to people on a routine basis when there’s something interesting. We want to stay in front of people, but we also want to have credibility so that when they’re opening their email, they don’t just immediately toss it aside because it says, “Hi, how are you? We’re having a barbecue. How’s your summer going?” We want to keep the information high quality in front of them.

Joe Fairless: I dislike it when people email me, “Hi, how are you?” and then they get to what they really wanted, because they don’t really care how I am. They just want to make the point or ask the question they really want to ask; which is totally fine, they should. But no need to get into social conventions on the “How are you?”, because if I actually think about it and respond thoughtfully, I tell them how I am, it doesn’t really matter.

Steve O’Brien: Yeah. Well, if you’re like me, you get so many emails that I wish I could take my email inbox, and just make everything only the stuff that I need to see. That doesn’t mean that I don’t get a random email that’s not very important that I want to read, but it’s hard to know of the hundreds of emails I get a day or however many I get a day, maybe 25 are really important and another 25 are stuff that I would really like to get to, and the rest it feels like it is clutter. So we try and stay out of the clutter and only send something when it’s meaningful.

Joe Fairless: Okay, so that’s the newsletter. It’s more keeping up on the market, macro level. What about the quarterly and monthly reports?

Steve O’Brien: The monthly reports are more of a traditional financial reporting structure that I think, in my opinion, everyone should provide. We will often include, depending on who is receiving it and what they want to see, rent roll, balance sheet, financials, bank reconciliations, different data that shows your client, “Hey, I’m watching this asset for you. We are paying attention.” We’re vertically integrated and a management company too, so we like to take every opportunity to remind our investors that when you invest with us, every nickel that you give us never leaves our sight, all the way down to paying the property manager and the maintenance team on site, we’re in control of your money and we’re watching. So that’s our monthly report. It is a straight financial report.

The quarterly report really gets in-depth and talks about the statistics, analyzing this quarter versus last quarter, returns and market details. Part of the reason we like that one, I think, is it gives you an opportunity to talk about how this deal is affected by the market, the returns, you’re getting, what you’re seeing and where you expect it to go. So that’s a great way to communicate with investors, especially when, in our opinion, the best way to raise more money in the future is by taking care of the people that you have. So for instance, for us right now, we’re in the middle of raising a fund, and because we communicate so much with our investors, and we share those quarterly reports, the investors that are already with us when we call them and say, “Hey, I’ve got something new for you”, they’re more up to speed on the market. So it’s not like you’re starting from scratch when we’re saying, “Hey, this is what we’re doing with our fund.” If they’ve read our quarterly reports, a lot of our investors will say, “Oh, that’s great. So you guys are making an adjustment based on what you’re seeing in the market. That’s smart.” And it actually helps you raise money.

Joe Fairless: Contractors and then to the first point, contractors who provide good and accurate pricing, sometimes people overestimate what it will cost. But if you have a good contractor, and to your example, 250k versus 500k, then you’ve got a 250k spread there. What are some specific things that you do due diligence on with contractors, that a good contractor could identify some cost savings that others are ballparking numbers?

Steve O’Brien: Sure. I think this actually moves in both directions, too. Sometimes, when we’re bringing on a contractor that we trust– I think windows are a great example of your question. Windows come in all different shapes and sizes and different manufacturers. If you get a really standard window size, and the requirements of the local municipality or county or city are very standard, you can find windows that are very inexpensive. But you find yourself in a coastal market where, like we just saw in southeast down here by Florida and Georgia, north of South Carolina, and a hurricane comes through, a lot of those municipalities have very heavy requirements for the type of windows you have. So when I say that it can work in both directions, sometimes your contractor can find you a great price.

Other times while you’re early in your process, if you know it needs new windows, or it needs a new roof, you can actually figure out what it’s really going to cost to do it, if you have a good contractor. Sometimes that can get you to the broker and the seller. And maybe they don’t realize the problem that they’ve got. You’re the first one to go back to them and say, “Hey, I know you guys think you could replace the windows on this for $200,000. But did you realize that it has to be shatter resistant and hurricane glass etc, etc?” Sometimes that can help you show that you’re more diligent and make the buyer feel more comfortable with you because they’re just waiting on someone else now to come up with that same information.

Buyers want to sell and they want a real price. Yeah, they want the max price. But there are plenty of horror stories, and I’ve been that seller too. The sellers want the highest price they can get, but they also want it to be real. You do 60 days of diligence in closing or whatever, and they come back and re-trade you because they didn’t do a good enough job on the front end. That’s painful as a seller to have to go start that process over again. So having a good contract, whether it’s giving you a really big number or a really small number, I think it can really help from a credibility standpoint. And credibility definitely helps you win deals.

Joe Fairless: Tell us a story of when that happened to you as a seller, the re-trade, and they weren’t informed enough.

Steve O’Brien: Yeah, I’ll give you a perfect example in a deal that didn’t sell. We’ve had a deal in the Atlanta area where someone approached and gave us a very big number, and said a lot of the things that buyers are saying right now that set up are red flags. “Oh, I’ve got a 1031. I know this area. I love this market, and this is what we’re thinking.” Then you go down over that–

Joe Fairless: That’s a red flag? “I got 1031 money; I know the market”?

Steve O’Brien: It can be if somebody is coming to you and saying those things. “Here’s what we’re thinking about your deal,” and you find out that they don’t have a deal in that neighborhood. I think brokers and some buyers right now know that those are buzzwords that attract people, so they get your attention early. In reality, maybe it is a 1031, maybe it’s not, but a lot of 1031 buyers are identifying three or more properties, or up to three, I believe. So sometimes they can drag you in when what they’re really trying to do is make sure they’ve got a place to put this money. That happened to us. So it just raises our hackles when somebody approaches us totally unsolicited, and offers you a really big number. That’s what happened in this instance.

So we started going down the road and as we started to offer to send them information, it started to fall apart on us, meaning, “Yeah, that looks good.” Then you start asking some specific information, and you realize they haven’t really underwritten the deal. So that could be for a number of reasons. It could have been because they weren’t serious, or could have been because they tried that shotgun approach, and they did that with 100 different properties, and that’s all they were trying to do was find three or four to buy. A lot of times we see that with 1031 – it’s great because people will have pressure to get a deal under contract and acquire it. But also 1031 money can be tough, because you’re gonna sell for a really big price. But they’ve identified another property, and they waste your time, figuring out, making sure that they put this money to work, and it turns out you were their third choice of the three that they identified.

So it’s definitely worth spending your time on, but I think the thing that we always say is like, “If it sounds too good to be true, it probably is.” So somebody shows up and is offering to pay you a lot more than you think something’s worth for some pressure reason that they have – we tend to be very wary of that situation.

Joe Fairless: Initially, were they non-refundable on any money?

Steve O’Brien: They were not. That’s, I think one of the keys as a seller right now, especially in a market where in a lot of instances you’re able to get non-refundable money going in. But again, we got to be careful because almost all the time when we’re negotiating nonrefundable initial earnest money, if you really dig in and spend the time negotiating, it takes you a couple weeks to negotiate all the rules there, and they’re getting a two-week free look in that timeframe. I’d say, we’ve gone back to and forth for up to a month, just negotiating the non-refundable earnest money, because in our experience, not all non-refundable earnest money is considered equal. There is a lot of outs. Whether it’s reasonable outs like environmental, or other outs– they’ll say it’s non-refundable, earnest money, then they’ll say if there’s any sort of misrepresentation like the rent roll’s not accurate, they consider that a misrepresentation. So it’s refundable at that point. So you’ve got to be very careful. I think people go around throwing around the word hard money right now, and it’s not all the same. It’s very dependent on what the agreement says.

Joe Fairless: Yes, very much. Anything else, as it relates to finding good investments in competitive markets that we haven’t talked about that we should before we wrap up?

Steve O’Brien: The only last thing that I’d leave your listeners with is the idea that if everybody is chasing something in particular, it could be a smart idea to look in a slightly different area. That’s what we’re starting to do now… Meaning, there is an enormous amount of money raised throughout the country, particularly in the southeast where we’re based, for opportunistic or value-add apartment investing. So if that’s what everybody’s looking for, there may be some other type of investment opportunities in multifamily or other types of products that are being missed. So we’ve been very thorough, and as I mentioned, we’re starting to turn a little bit and start looking where other people aren’t. Because cap rate compression is getting to the point where– I’ll give you a perfect example. We’ve recently seen a Class A deal in a market in the Southeast that was built in 2014, that it looks like was going to trade at a five and three quarters cap. Down the street from that property, another property that was in the same market, but 30 years older, was going to trade for a five cap. To me, I think time will tell, but that’s a big spread between high quality almost brand new product that you can acquire with really attractive debt these days, and a type of property where there may be a big upside, but you’ve actually got to execute the plan perfectly in order to get that five cap up to the six and a half or the seven.

So I think we’re starting to look in new areas for some mispricing or areas where 40 people are making offers on this one property… What about this other property here that only got two offers? What’s the story with that one? Is there any opportunity to buy something at a better deal just because it doesn’t fit the mold for most of the capital chasing deals right now?

Joe Fairless: How can the Best Ever listeners learn more about what you’re doing?

Steve O’Brien: The website is the best place for us – www.arcancapital.com.

Joe Fairless: Three ways that we can be competitive or find good opportunities in an ultra competitive market… Well, you discussed four really. One is being focused on doing what you say you’re going to do, so have a good reputation. Two is having enough data so you can push in ways that other people haven’t figured out.  For example, having a good contractor. You gave some examples about that, and in particular the windows example. Three, communicating with your investors to level set with them the type of returns that are available at this point in time. Then four, going in a slightly different direction to — they call it the blue ocean strategy. The last thing I learned is the term “raises our hackles.” I had to google that. Thank you for sharing it with me a new term.

Steve O’Brien: Oh, good. That’s great.

Joe Fairless: “Make one very angry”, raise one’s hackles. Never heard that. So I really appreciate you sharing your advice, talking about your experiences and I’m looking forward to staying in touch. I hope you have a best ever day, and we’ll talk to you again soon.

Steve O’Brien: Great. Thanks for having me.

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